The move to open the first solar plant in the Dominican Republic is a welcome step for the country’s struggling power sector. However, more remains to be done…
Power cuts are all too frequent in the DR, a daily problem that shouldn’t occur in one of the region’s richer economies. Unfortunately solving the problem is more complicated than just building a power plant or two. Unlike other countries, where electricity outages occur when supply can’t meet demand, the Dominican Republic has an abundant supply of installed generating capacity. Instead the problem lies in a tangled web of political interest and inefficient business models.
“The main problem is the lack of operational efficiency of the distribution companies…”
The power system in the DR is split into three parts: the generation companies, most of which are privately owned, the transmission network, which in common with many parts of the word is state-owned, and the distribution companies, that were re-nationalised after an unsuccessful spell of private ownership. Most energy experts agree that the fault lies with the distribution companies.
“The main problem is the lack of operational efficiency of the distribution companies”, explains Marcelo Aicardi, General Manager of Ege Haina, the biggest power generator on the island. “The distribution companies lose around 35% of the electricity to theft so they mitigate the financial impact of this by cutting the service to the population.” Electricity theft is common in many emerging markets, yet there are plenty of examples of developing countries that have reduced it to more manageable levels, say 10% to 15%. But most experts believe that the Dominican Republic’s state-owned distribution companies don’t confront theft because of the political cost for the government. “The government has shown it doesn’t have the willingness to face the issue of the collection of electricity bills, certainly not before the election”, says Leonel Melo, founding partner of OMG a law firm and research institute.
Another financial problem for the distribution companies is the tariff system. During the years of high fuel prices – around 50% of the DR’s power is generated from imported fuel oil – the official tariff didn’t raise enough to compensate for the increased costs. It meant that in effect the government was subsidising electricity.
“That creates enormous economic burden on whole sector”, says Melo. “The distribution companies were suffering but they transferred it to the generators by delaying payments, this financial stress is then transferred to the banking community before eventually the government uses some creative means – perhaps involving the social security system – to find the money to pay the generators.”
The brutal combination of unofficial subsidies and theft put the distribution companies under enormous pressure, says Amauris Vásquez Disla, founding partner of local law firm De Camps, Vásquez & Valera. “International prices of fuel have dropped but this has not translated to a fall in the price of Dominican electricity. The power generation companies have dropped the price they charge to distribution companies but the distribution firms are not passing on the cuts, instead they are using it as a chance to repair their balance sheets.”
Aicardi believes it is fair that, after years of subsidising energy, the state-owned distributors use the current low-price environment to recover. However, he believes that even the low fuel prices can’t fix the problem. “Even with distribution companies purchasing at 10 cents per kilowatt hour and selling it at 17 cents per kilowatt hour they still lose money because of the massive losses.”
Challenge or opportunity?
One of the biggest clichés in investment journalism is that challenge represents opportunity. It’s a well-worn trope yet like most clichés it’s often true. For example, if the government decided to re-privatise the distribution companies it would create a series of huge tenders.
“The climate for change is definitely here as there is strong public feeling regarding current price of electricity”, says Vásquez. That view is share by Aicardi. “Two to three years ago the private sector just wanted cheap electricity. With fuel prices what they were, the only thing industrial users wanted was a lower energy cost, so they were not paying attention to the government energy policy – they believed that more power generation was the answer.”
“But now the private sector is realising that having more capacity and more generation is not the real solution because today we have very low fuel prices and the distribution companies continue to be in negative territory and keep losing money… In this climate the likelihood that they would be privatised at some point seems more likely.”
If the Dominican government does open up the distribution companies to international capital and expertise there will be a lot of interest. However, Aicardi believes that certain key criteria, such as a more robust attitude to electricity theft and more realistic tariffs, would need to be established.
The carbon factor
Although you wouldn’t think it from the power cuts, generation companies in the Dominican Republic have been investing heavily in updating their plants. “Over the last 15 years generators have invested $2.5billion dollars and succeed in improving the efficiency of the generation fleet from 14,000 btu [British thermal units], to 8,500 btu, meaning the country has the generation capacity that it needs”, says Aicardi. Yet despite this investment the country’s power demand has stagnated. It consumes roughly the same amount of electricity today that it did in 2003, which is staggering when you consider that the economy has doubled in that time.
Aicardi believes that the main reason is the enforced rationing by inefficient distribution companies. Another factor may have been the strong growth of non-energy intensive sectors such as tourism and finance. However it’s clear that the DR’s fast-growing economy will need more energy in the future. The government response was to commission two huge (relatively for the size of the network) coal-fired plants, which will add 700MW of installed capacity.
Like any huge project the $2.5billion plan has its defenders and detractors. No-one can deny that it will provide a cheap source of reliable energy supply, however, it seems an odd move to commit the DR to coal at precisely the moment that the rest of the world is making more commitment to renewable energy technology. Combined with the existing fuel oil plants it will create a very carbon-heavy generation system.
Many feel that the money would have been better spent on incentives for the renewable sector. “It would make sense for more renewable energy”, says Delio Zuñiga, Senior Partner, KPMG Dominican Republic. “At present there is a heavy reliance on fuel oil, which is a relatively dirty fuel and is subject to fluctuating oil prices. Given the DR’s reliance on tourism it makes sense to protect the natural beauty of the island by using renewable energy.”
There is also frustration among businesspeople that have been unable to get renewable projects of the ground. “It’s almost impossible to launch a renewable project”, says Marcos Cochón, General Manager of Compañía de Electricidad de Puerto Plata (CEPP), a company that runs a fuel-oil plant on the north coast of the Dominican Republic. “I have been trying but the government doesn’t offer renewable projects the PPAs [Purchase Power Agreements] needed to get project financing, so I don’t see how they expect them to happen.” One firm that has succeeded with renewable technology is Ege Haina, which has around 350 MW of wind farms. “The reason is that we were able to build it on our balance sheet, without a PPA”, explains Aicardi. “I can see how someone looking to make it happen through project finance would struggle.”
Providing power solutions is a guaranteed way for investors to gain exposure to fast-growing emerging economies. The problems that bedevil the DR’s electricity system mean that there are still a lot of ways for LatAm INVESTOR readers to get involved. However, most would be looking for signs that conditions for those investing in the two major opportunities – distribution and renewable – will improve. At time of going to print, key stakeholders in the industry were debating a Pacto Eléctrico. The fact that the private and public sector decided to work together to solve the sector’s challenges is an undoubted positive. Yet given that strong political leadership will be needed to execute any changes, investors will be waiting until after the elections in May.